Money includes both currency, particularly the many
circulating currencies with legal tender
status, and various forms of financial deposit accounts, such as
demand deposits, savings accounts, and certificates of deposit. In
modern economies, currency is the smallest component of the
money
supply.

Money is not the same as real value,
the latter being the basic element in economics. Money is central
to the study of economics and forms its most
cogent link to finance.
The absence of money causes a market
economy to be inefficient because it requires a coincidence
of wants between traders, and an agreement that these needs are
of equal value, before a barter exchange can occur. The
use of money is thought to encourage trade and the division
of labour.

Economic characteristics

Money is generally considered to
have the following characteristics, which are summed up in a rhyme
found in older economics textbooks: "Money is a matter of functions
four, a medium, a measure, a standard, a store." That is, money
functions as a medium
of exchange, a unit of
account, and a store of
value.

There have been many historical arguments
regarding the combination of money's functions, some arguing that
they need more separation and that a single unit is insufficient to
deal with them all. One of these arguments is that the role of
money as a medium
of exchange is in conflict with its role as a store of
value: its role as a store of value requires holding it without
spending, whereas its role as a medium of exchange requires it to
circulate. Credit money differs from commodity and fiat money in
two ways: It is not payable on demand (although in the case of fiat
money, "demand payment" is a purely symbolic act since all that can
be demanded is other types of fiat currency) and there is some
element of risk that the real value
upon fulfillment of the claim will not be equal to real value
expected at the time of purchase.

The second source of risk is time. Credit money
is a promise of future payment. If the interest rate on the claim
fails to compensate for the combined impact of the inflation
(or deflation) rate
and the time
value of money, the seller will receive less real value than
anticipated. If the interest rate on the claim overcompensates, the
buyer will pay more than expected.

Over the last two centuries, credit money has
steadily risen as the main source of money creation, progressively
replacing first commodity and then representative money. In many
cases credit money has been converted to fiat money (see below), as
governments have backed certain private credit instruments (first
banknotes from central banks, then later certain types of deposits
to banks), thus converting central banknotes to legal tender, and
other types of notes (deposit certificates of less than a certain
value) to a status not very different from fiat money, since they
are backed by the power of the central government to redeem
eventually with tax collection.

A particular problem with credit money is that
its supply moves in line with the business
cycle. When lenders are optimistic, notably when the debt level
is low, they increase their lending activity which creates new
money. This may also trigger inflation and bull markets.
When creditors are pessimistic (for instance, when debt level is
perceived as too high, or unwise lending activity in the past has
resulted in situations where defaults are expected to follow), then
creditors reduce their lending activity and money becomes "tight"
or "illiquid." Bear markets,
characterized by bankruptcies and market recessions, then
follow.

Fiat money

Fiat money is any money whose value is determined
by legal means, rather than the strict availability of goods and
services which are named on the representative note.

Fiat money is created when a type of credit money
(typically notes from a central bank, such as the Federal
Reserve System in the U.S.) is declared by a government act
(fiat) to be acceptable and officially-recognized payment for all
debts, both public and private. Fiat money may thus be symbolic of
a commodity or a government promise, though not a completely
specified amount of either of these. Fiat money is thus not
technically fungible or tradable directly for fixed quantities of
anything, except more of the same government's fiat money. Fiat
moneys usually trade against each other in value in an
international market, as with other goods. An exception to this is
when currencies are locked to each other, as explained below. Many
but not all fiat moneys are accepted on the international market as
having value. Those that are trade indirectly against any
internationally available goods and services . By contrast,
commodity money which has been destroyed or lost is gone.

Paper currency is especially vulnerable to
everyday hazards: from fire, water, termites, and simple wear and
tear. Currency in the form of minted coins is more durable but a
significant portion is simply lost in everyday use. In order to
reduce replacement costs, many countries are converting to plastic
currency. For example, Mexico has changed its twenty and fifty peso
notes, Singapore its $2, $5, $10 and $50 bills, Malaysia with RM5
bill, and Australia and New Zealand their $5, $10, $20, $50 and
$100 to plastic, both for the increased durability and because
plastic may be easily specifically constructed for each
denomination, thus making it impossible for counterfeiters to
"lift" or raise the value of a bill by using the material of a bill
of lesser value as a primary source to make a counterfeit note of
higher value.

Some of the benefits of fiat money can be a
double-edged sword. For example, if the amount of money in active
circulation outstrips the available goods and services for sale,
the effect can be inflationary. This can easily happen if
governments print money without attention to the level of economic
activity, or if successful counterfeiters flourish.

A criticism of credit and fiat moneys relates to
the fact that their stabilities are highly dependent on the
stability of the legal system backing the currency: should the
legal system fail, so will the value of any type of money that
depends on it. However, this situation is typical of the
maintenance of the value of any promisory note system: if a
guarantor creates money or wealth by means of any legal promise to
provide goods or services in the future (as is the case with both
credit and fiat type moneys), then any failure of a legal system
which backs up the rights of the debt-holder to collect on the
promise, will act to jeopardize the value of future promises.

Money supply

The money supply is the amount of money within
a specific economy available for purchasing goods or services. The
supply in the US is usually considered as four escalating
categories M0, M1, M2 and M3. The categories grow in size with M3
representing all forms of money (including credit) and M0 being
just base money (coins, bills, and central bank deposits). M0 is
also money that can satisfy private banks' reserve requirements. In
the US, the Federal
Reserve is responsible for controlling the money supply, while
in the Euro
area the respective institution is the European
Central Bank. Other central banks with significant impact on
global finances are the Bank of
Japan, People's
Bank of China and the Bank of
England.

When gold is used as money, the money supply can
grow in either of two ways. First, the money supply can increase as
the amount of gold increases by new gold mining at about 2% per
year, but it can also increase more during periods of gold rushes
and discoveries, such as when Columbus discovered the new world and
brought gold back to Spain, or when gold was discovered in
California in 1848. This kind of increase helps debtors, and causes
inflation, as the value of gold goes down. Second, the money supply
can increase when the value of gold goes up. This kind of increase
in the value of gold helps savers and creditors and is called
deflation, where items for sale are less expensive in terms of
gold. Deflation was the more typical situation for over a century when gold and credit
money backed by gold were used as money in the US from 1792 to
1913.

Monetary policy

Monetary policy is the process by which a
government, central
bank, or monetary authority manages the money supply
to achieve specific goals. Usually the goal of monetary policy is
to accommodate economic growth in an environment of stable prices.
For example, it is clearly stated in the Federal
Reserve Act that the Board of
Governors and the
Federal Open Market Committee should seek “to promote
effectively the goals of maximum employment, stable prices, and
moderate long-term interest rates.”

A failed monetary policy can have significant
detrimental effects on an economy and the society that depends on
it. These include hyperinflation, stagflation, recession, high unemployment, shortages of
imported goods, inability to export goods, and even total monetary
collapse and the adoption of a much less efficient barter economy.
This happened in Russia, for instance, after the
fall of the Soviet Union.

Governments and central banks have taken both
regulatory and free market approaches to monetary policy. Some of
the tools used to control the money supply include:

taxation or tax breaks on imports or exports of capital into a
country

raising or lowering bank reserve requirements

regulation or prohibition of private currencies

For many years much of monetary policy was
influenced by an economic theory known as monetarism. Monetarism is an
economic theory which argues that management of the money supply
should be the primary means of regulating economic activity. The
stability of the demand for money prior to the 1980s was a key
finding of Milton
Friedman and Anna
Schwartz supported by the work of David
Laidler, and many others.

The nature of the demand for money changed during
the 1980s owing to technical, institutional, and legal factors and
the influence of monetarism has since decreased.

History of money

According to some fables, inventors of
money were Demodike (or
Hermodike) of
Kymi (the wife
of Midas),
Lykos (son of
Pandion
II and ancestor of the Lycians) and Erichthonius,
the Lydians
or the Naxians.
However, the use of proto-money may date back to at least 100,000
years ago, and the use of precious metals as money dates back at
least 6000 years. The use of gold as money has been traced back to
the fourth millennium B.C. when the Egyptians used gold bars of a
set weight as a medium of exchange, as the Sumerians had done
somewhat earlier with silver bars. Coins or at least minted tokens
of a fixed value first appear in the 7th century BC in Greece. The
first banknotes was
used in China in the 7th century, and the first in Europe was
issued by Stockholms
Banco in 1661.